Daily Archives: 28 November 2011

Can We Afford This?

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The International Monetary Fund, reports Belmont Club, is being lined up bail out Italy and Spain to the tune of an $800 billion aid package.  With the US as the IMF’s largest contributor, our “share” of this works out to more than $140 billion.  Can we afford this bailout (I won’t go into “after all the other bailouts” in which our government—we—have participated, both domestically and foreign)?  As an old econ professor of mine used to ask, “Suppose not?”  That is, what are the consequences of our not participating in this new bailout scheme?

Here’s one estimate of those consequences.  The EU’s designated “systemically important” banks hold a lot of European sovereign debt, including, in particular, Greek, Spanish, and Italian (and Portuguese) debt.  So do a lot of the other European banks.  So do a lot of Europe’s national central banks.  On top of this, most of the rest of Europe’s major banks hold the debt (non-sovereign; commercial) debt of those commercial entities that hold all that sovereign debt.

Because of these risks, the EU governing bodies have required those major banks to increase their capital reserves to 9% of their assets in anticipation of a Greek, or other sovereign, default.  But instead of acquiring more capital to reach that 9% threshold, those banks have been busily reducing their asset base to get their existing reserves to 9% of that reduced base—beginning with unloading the sovereign debt they presently hold.  Beyond this, the banks are not buying anymore sovereign debt, in what Spiegel Online International refers to as a “buyers’ strike on euro-zone debt.”  Mutual funds, money market funds, and other financial entities outside the EU have stopped buying European debt, also, even to the point of the US Federal Reserve Bank having to make dollars available to Europe because the commercial entities are even decreasing their willingness to roll over short term debt instruments.  It’s gotten so bad that not even Germany could sell its 10-year bonds in last week’s sale; one-third of their offering was left on the table.

In this environment, suppose Italy defaults (Greece has already defaulted with the agreed 50% write-down of their sovereign debt, but since sufficient government arm-twisting (“Nice banks you got there, Karl, Pierre.  Shame if something happened to them.”) was applied by the other European governments to get private lenders to “volunteer”, a “default” didn’t actually happen).  The banks still holding Italian sovereign debt fail because their assets—those debt instruments—become worthless and are (were) too much of their asset base.  This cascades as banks holding those banks’ own debt fail from the worthlessness of the failed banks’ debt.  And so on.  With the resulting severe economic downturn, the nations of the EU suffer, unemployment rises, output falls; all the things associated with a sharp, steep dislocation occur.  Since Europe is a major trading partner, and so customer, of ours, our economy worsens, our ongoing recession deepens, perhaps sharply, and lengthens.

On the other hand, suppose we go along with this IMF scheme and participate in yet another bailout.  What happens then?  The IMF money, claims La Stampa (via the Belmont Club link above), would give Italy a year to a year-and-a-half to push through reform without actually having to refinance their existing debt.  But, in reality, this just means the string will be pushed down the road.  Politicians, including Italian Prime Minister Mario Monti, won’t use the time to implement real reform, only to pay lip service while continuing to spend.  The rioting in the Italian streets over existing timid spending cuts show this (as they showed in Greece).

Further, with the cost of sovereign—and private—borrowing increasing rapidly as private entities—the only entities, in their aggregate, with the money to continue funding (but even for them, only to a point) national deficit spending, which is sovereign debt, what happens when the money runs out?  Recall that those private entities already are walking away from lending to Europe: they’re not going to lend until they run out of money.

Indeed, Spiegel Online International notes that their sources say that all of the previous bailout attempts have been worthless.  Those sources insist that, as a result, the European Central Bank must finance the debtor nations, even if the EU’s treaties bar it from doing so.  The central bank has enough money, goes the claim, and it can also print money if necessary.  Aside from what blithely ignoring the fundamental law of the land does for binding political entities—and people—together into a coherent polity, such printing of money for the sake of generating dollarseuros is the stuff of very great, if not runaway, inflation, as the Germans know full well.  Sharp inflation represents a devaluation of the currency that is little different from an outright default.

It won’t work, anyway—bailouts cannot work.  The prior bailouts failed, not because there wasn’t enough money transferred, but because the concept of bailouts is a failure: all they do is reward the behaviors that led to the condition by excusing the actors from the consequences of their actions.

In the end, then, Italy (Spain/Portugal) will default anyway.  Only if we’re active participants, we’re out those $140 billion, and a lot more, as all of us, EU and the US, keep trying until the inevitable happens.  Better to cut the cord, stop feeding the habit.  Better if the EU did this, also.  The default will happen sooner, the economic downturn will be extremely sharp, and it will be over.  The defaulting nations will recover, and they’ll be stronger than before for having learned a painful lesson.  For a couple of generations, anyway.  The rest of the nations will be better off, and sooner, for not having ridden this sinking ship down.

Distorting the Question

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There they go again.

Senator Dick Durbin (D, IL) suggests that the Republicans are being a tad disingenuous with their reluctance to extend the payroll tax “cut” of two per centage points on employee payrolls.  Pretending to not understand the reluctance, Durbin asserts

The Republican position is they’d raise the payroll tax on working families.  That just defies logic.  What we should do is to help these working families struggle through.

What defies logic, though, as Durbin understands full well, is the concept of reducing the payroll tax in the first place.  Regardless of what we might think of the present structure of Social Security and Medicare, the fact is both of these programs are within just a very few election cycles of being utterly bankrupt, and the payroll tax is the only way—by design—of funding these programs.  Reducing that funding only hastens those failures.

Americans aren’t as dumb as Progressives like Durbin would have it, either, and so we’re fully capable of seeing the foolishness of a payroll tax cut, and we’re fully capable of not confusing such a cut with an income tax cut.  Indeed, far from the jobs stimulus the Progressives claimed this would be when President Obama proposed the cut, most Americans promptly saved those few extra bucks, or used them to pay down personal debt.  Of course, since businesses had no such cuts to their payroll expenses, they received no incentive to hire, and the missing “cut” spending potentiated that lack.

Aside from this, though, the Durbin claim is little more than a Progressive distortion of the opposition party’s tax position.  To use the payroll tax reluctance in this way—as a “demonstration” that Republicans want to raise taxes in the middle of this deep recession—is to isolate one irrelevant position, payroll taxes that have nothing to do with jobs and everything to do with the way Social Security and Medicare are funded, and to ignore the whole position: that lower income and business tax rates are themselves job creators and further that they increase tax revenue through increased economic activity—producing, selling, hiring—which leads to additional hiring in a virtuous circle.  Which “help[s] these working families struggle through.”

Further, Republicans have been advocating for some time closing tax loopholes and ending subsidies as an additional means of raising revenues, another aspect of their composite tax position that Durbin carefully elides.  And his distortion ignores the fact  that the Progressives themselves insist on outright tax rate increases—to the tune of $1 trillion, as Obama threw in at  the last second to blow up an already tentatively agreed deal during the debt limit increase talks last summer, and which the six Progressives on the recently deceased Supercommittee used to blow up that group’s chances of fulfilling its mandate.

Then Durbin added a wholly irrelevant canard to explain Obama’s absence from the just concluded Supercommittee charade:

This was a congressional undertaking. And the Republicans made it clear that if President Obama weighed in, it would become another presidential issue.

Really?  In what way?  Durbin chooses to offer no facts to support his assertion.  He does choose to ignore, though, the fact that Obama has repeatedly refused Republican invitations to talk about any economic matter, preferring instead to hit the campaign trail and to dally in Bali for East Asia summit talks.